The “picks and shovels” of the oil sector have been destroyed.
The price of oil is now down 59% from its June 2014 peak. A barrel of crude currently costs $44.39. It hasn’t been that cheap since the financial crisis.
The big oil companies are struggling like you’d expect. Exxon is down 21% in the last year. Chevron is down 33%. ConocoPhillips, the largest independent US oil and gas company, is down 38%.
We told you earlier this week that big oil companies like Exxon are drastically cutting back spending to survive the crash in oil prices.
Oil companies have laid off more workers during the first half of 2015 than during the past three years combined. And they’ve delayed or canceled $200 billion worth of projects this year.
Reuters reported that ConocoPhillips is cutting spending:
[The company said] it would cut capital expenditure as low crude oil prices persist.
The Houston-based company said it would cut 2015 capital spending to $11 billion from $11.5 billion, and also lowered its forecast for operating expenses.
Chief Executive Officer Ryan Lance said Conoco was preparing for “lower, more volatile prices.”
• Oil service companies are the “picks and shovels” of the oil industry…
Oil service companies sell equipment and services to big oil companies like Exxon and ConocoPhillips. When a big oil company like ConocoPhillips cuts “capital spending,” it usually buys less from oil service companies.
Schlumberger and Halliburton are the two biggest oil service companies. Both reported bad results in July. Here’s Bloomberg on Halliburton:
Halliburton has seen sales fall 39 percent in the U.S. and Canada where the industry has reduced the number of operating drilling rigs by more than half. Explorers have cut more than $100 billion from global spending plans for the year after oil prices fell by half from a high in June 2014.
And here’s the Wall Street Journal on Schlumberger:
Schlumberger Ltd.’s second-quarter earnings fell 30% on plunging revenue, as the oil-services sector continues to grapple with weak oil prices.
Schlumberger reported a profit of $1.12 billion, or 88 cents a share, down from $1.6 billion, or $1.21 a share, a year earlier. Revenue dropped 25% to $9.01 billion.
Halliburton’s stock dropped 41% over the past year. Schlumberger’s dropped 24%. OIH, an ETF that holds the largest oil service companies, dropped 42%.
Stocks of the smaller oil service companies have dropped even more. National Oilwell Varco’s (NOV) stock fell 51% in the last year. Seadrill’s (SDRL) fell an incredible 78%.
Both of these companies earn most of their revenue by selling, leasing, or operating drilling rigs. When oil prices are low, big oil companies just don’t use their services as much.
Oil service is a cyclical industry. It goes through huge booms and huge busts. These stocks will soar again someday, as all cyclical industries do after huge busts.
The oil service sector is on our crisis watch list. But it’s too early to buy. We expect more pain in the oil service industry before we see a bottom.
• There’s one cyclical industry that has likely bottomed…
Gold miners go through huge booms and busts just like the oil service sector. The HUI Gold Bugs index, a popular index of gold mining stocks, gained 1,702% during the bull market that began in the early 2000s.
Now it’s down 83% since mid-2011.
Those might sound like incredible numbers. But they’re actually normal for gold mining stocks. Gold mining stocks are probably the most volatile stocks in the world. Get in at the wrong time and you’ll learn a painful lesson. But if you get in at the right time, they can make you obscenely rich.
As we mentioned, huge booms follow huge busts in cyclical industries. And we think gold miners are ready to boom again. After falling 83% in the last three-and-a-half years, they’re like a coiled spring waiting to explode.
• Switching gears, a US territory has defaulted on its debt…
On Monday, Puerto Rico missed a $58 million bond payment. It was Puerto Rico’s first default in 117 years.
The New York Times explained:
For years, the commonwealth borrowed too much money, trying to paper over declining government revenue and prevent deep cuts in services and layoffs of public workers. Puerto Rico easily found lenders willing to extend the government more debt. The bonds made for hot investments across the mainland United States because the interest is often “triple tax exempt,” meaning the holder does not pay state, federal or city income taxes.
A default by Puerto Rico was bound to happen. For years, the government spent more money than it snatched up in taxes. And it borrowed to make up the difference.
It doesn’t matter if you’re a person, a company, or a government. You can only hide a spending problem by borrowing for so long.
Puerto Rico owes creditors $73 billion. But it can’t declare bankruptcy. The Economist explains why:
Because Puerto Rico is not a state, it cannot make use of the public-sector version of federal bankruptcy law known as Chapter Nine, which has been invoked by insolvent governments on the mainland (such as Detroit) to reduce their liabilities.
Puerto Rico’s Governor Alejandro García Padilla wants to rework the payment schedule with creditors. He said:
The goal is going to be a moratorium that is negotiated with bondholders to delay debt payments for a number of years, so money is available to be invested here in Puerto Rico, to create jobs. … By sharing the sacrifice with our creditors, we will be able to move forward.
Víctor Suárez, Padilla’s chief of staff, explained why Puerto Rico didn’t pay its bill when he simply said, “We don’t have the money.”
There’s been talk that Puerto Rico’s debt problems could spill over into US cities with shaky finances. We’ll know more by September 1. That’s when Puerto Rico’s government will have a proposal for restructuring the debt.
• Casey Research has boots on the ground in Puerto Rico…
Casey Research Senior Investment Strategist Louis James lives in Puerto Rico. He says things aren’t perfect there. But they’re not terrible, either:
I see a lot of recently shuttered businesses. There’s a Radisson around the corner from my place that closed a couple months ago, and the entire neighborhood is much quieter.
But I’m seeing new businesses as well. It’s easy for reporters to fly in and find some boarded up windows to stand in front of while on camera. But I see gentrification of some areas.
Louis added that the Puerto Rican government is willing to cut its spending:
Meanwhile, the government is actually cutting spending. Can you imagine? What a concept!
And I don’t mean decreasing the budget increases and calling that a cut, as they do in Washington. I mean real, bona fide reductions in government spending.
This will, of course, cause all sorts of pain and political backlash. But if the government has the cojones to do enough of it and see it through, Puerto Rico could become an amazing turnaround story and end up a shining example to the rest of the United States.
I doubt that will happen though. As Doug Casey says, if there’s one thing you can count on, it’s for governments to do the wrong thing.
Chart of the Day
Today’s chart compares the two biggest crashes in the price of oil since 2000.
The current crash is bad. Oil is down 59% from its peak in June 2014.
But it’s not even close to as bad as the crash during the financial crisis. In 2008/9, oil crashed from its all-time high of $145.31 down to $30.28 per barrel… a decline of 79%.
Yesterday, the price of crude fell to $44.39 per barrel. It’s very close to breaking below its recent low of $44.02. It would still need to fall about another 50%, down to $22.67, to be as big a crash as the one during the financial crisis.
As we showed you earlier, oil companies are already having a hard time with oil at $44 per barrel. If oil drops to anywhere near $22, expect to see a huge wave of bankruptcies.
Delray Beach, Florida
August 07, 2015